Creditor Protection for Life Insurance and Annuities

More documents

Recommendations

Info

marketed—as a tax-favored investment vehicle), but significant issues remain. Notwithstanding these factors, the potential value of such exemptions to a debtor or potential debtor means that the exemptions warrant a careful and considered review by both asset protection planners and bankruptcy counsel acting in a pre-bankruptcy planning function. (Although foreign life insurance and annuity products may offer more protection from creditors than do their domestic counterparts, such products are beyond the scope of this article.) Life Insurance Consideration of the potential creditor protections afforded to life insurance contracts is complicated by the several capacities in which the debtor may have an interest in the policy. For example, the debtor can be the owner of the policy, the insured, or both the owner and the insured. Alternatively the debtor may be the beneficiary of the policy or the owner of a policy that names his or her estate as the beneficiary of the policy. To further complicate matters, since the exemptions afforded to life insurance are intended to further particular public policy goals (i.e., protecting the debtor’s dependents from financial destitution in the event of the debtor’s untimely demise), the relationships between the owner and the insured and between the owner and the beneficiary are often key to determining whether and to what extent the particular life insurance policy at issue may be protected from creditor claims. These additional permutations exponentially increase the complexity of determining whether the life insurance policy may be exempted in any particular circumstance. The federal bankruptcy exemptions for life insurance policies owned by the debtor are found at 11 U.S.C. sections 522(d)(7) and (8), where their relative importance to the average person is, perhaps, evidenced by their placement between the exemptions for the debtor’s professional books and tools of the trade and the debtor’s professionally prescribed health aids. More specifically, the federal bankruptcy exemptions for life insurance shield unmatured policies owned by the debtor (other than a credit life insurance contract) 5 and up to $8,625 6 of the debtor’s aggregate interest in any accrued dividend or interest under, or loan value of, an unmatured life insurance contract, provided that the insured is either the debtor or an individual of whom the debtor is a dependent. 7 Since, however, federal bankruptcy law broadly defines a dependent as including a spouse, regardless of whether the debtor’s spouse is actually dependent on the debtor, the exemption will apply without further inquiry so long as either the debtor or the debtor’s spouse is the insured. 8 The effect of the foregoing exemption is to protect the actual insurance element of the policy and little else, since only a minimal portion of the cash surrender value of the policy is afforded any exemption. While the exemption of an unmatured life insurance contract without the exemption of the cash surrender value may prove invaluable in certain limited circumstances (for example, if the debtor has become uninsurable since the life insurance policy was originally purchased), it obviously does not provide significant opportunities for asset protection or pre-bankruptcy planning for the insured. That the primary intent of the Bankruptcy Code as it relates to the exemption of life insurance is to protect a dependent’s interest in the life insurance policy, rather than the owner’s own interest, is further supported by 11 U.S.C. section 522(d)(11)(C). That section concerns the debtor as the 2
eneficiary of the policy (rather than as the owner of the policy) and exempts the debtor’s entitlement to the proceeds of a life insurance contract, without any specific dollar limitation, to the extent that such proceeds are “reasonably necessary” for the support of the debtor and any dependent of the debtor. For the exemption to apply the debtor has to have been a dependent of the insured at the time of the insured’s death. Since the federal exemption scheme for life insurance that is owned by the debtor is so parsimonious, if an exemption under an alternative state scheme is provided, it should be carefully considered. Following the model of the federal exemption scheme, some states provide very limited exemptions for the cash surrender value of life insurance. For example, South Carolina offers only a $4,000 exemption for the cash surrender value of life insurance (again, provided that the insured is either the debtor or an individual on whom the debtor is dependent). 9 Proceeds payable to the insured’s spouse, children, or dependents are, however, generally fully exempt from the creditors of the insured. 10 Wisconsin also exempts only $4,000 (provided that the insured is either the debtor, a dependent of the debtor, or an individual on whom the debtor is dependent). 11 If the debtor is the beneficiary of the life insurance policy, however, and provided that the debtor was dependent on the insured, Wisconsin law exempts payments to the extent reasonably necessary for the support of the debtor and the debtor’s dependents. 12 Other states, however, have exemption schemes that provide for far greater protection of the cash surrender value of life insurance policies than does the federal exemption scheme. For example, in keeping with its generally pro-debtor stance, Florida specifically exempts the entire cash surrender value of life insurance policies from the reach of creditors 13 and the entire death benefit from the creditors of the insured. 14 Hawaii similarly specifically exempts the entire death benefit and cash surrender value of life insurance policies from the reach of creditors of the owner of the life insurance policy, provided, however, that the policy is payable to a spouse of the insured, or to a child, parent, or other person dependent on the insured, except as to premiums paid in fraud of creditors. 15 Louisiana also specifically exempts the entire proceeds (including the full cash surrender value) of life insurance policies from the reach of creditors. The exemption is, however; limited to $35,000 of the cash surrender value if the life insurance policy was issued within nine months of a bankruptcy filing. 16 Exhibit 1 contains a state-by-state tabulation of the exemptions. New York’s scheme for the exemption of life insurance 17 is worth noting because it clearly distinguishes between the several permutations which can result depending on whether the debtor is the owner of the policy (referred to under the New York statute as the person “effecting the policy,” and need not be the person who actually purchased the policy), the insured, the beneficiary, or some combination thereof. More specifically, the New York State exemption scheme for life insurance provides that: 18 1. If the owner of a life insurance policy insures his or her own life for the benefit of another (i.e., a beneficiary other than the owner’s estate), that other person shall be entitled to the proceeds and avails of the policy as against the creditors of the owner. (In other words, the beneficiary’s interest in a life insurance policy owned by another is protected from claims of the policy owner’s creditors, notwithstanding the fact that a power to change the beneficiaries of the life insurance policy has been reserved.) 3
Page 1: Research Institute of America Group
Page 5 and 6: statute refers only to “monies pa
Page 7 and 8: illness, disability, death, age, or
Page 9 and 10: I agree that this statutory exempti
Page 11 and 12: 4. 504 U.S.573 (1992). 5. 11 U.S.C.
Page 13 and 14: State Exemption Table State Name Li
Page 15 and 16: District of Columbia Florida Up to
Page 17 and 18: Illinois Indiana Iowa Kansas 100% o
Page 19 and 20: Minnesota Mississippi Missouri Mont
Page 21 and 22: Ohio Oklahoma Oregon Pennsylvania R
Page 23 and 24: West Virginia Wisconsin Wyoming 100

Creditor Protection for Life Insurance and Annuities

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?